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Political Failures and Intergovernmental Competition

DOI: 10.1155/2012/409135

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In normative public economics, intergovernmental competition is usually viewed as harmful. Although empirical support for this position does not abound, market integration has intensified competition among developed countries. In this paper we argue that when assessing welfare effects of intergovernmental competition for various forms of political failures (the public choice critique), the outcome is ambiguous and competition can be welfare improving. 1. Introduction What is the role of competition between governments? If competition is the fundamental force of efficient economic performance in the private sector, why should it be different for the public sector? Why cannot the same disciplining effect of competition be applied to the public sector as well? In the private sector competition will promote efficiency because firms which best satisfy consumers’ preferences will survive and prosper, while others will lose customers and fail. Extending this argument to the public sector, competition among governments and jurisdictions should induce them to best serve the will of their residents. If they fail to do so, residents will vote out their incumbent or they can leave for other jurisdictions, which offer a better deal. The purpose of this paper is to show that if the normative public economics view of a harmful tax competition and a risk of a race to the bottom has some merit, it also needs to be seriously qualified. Indeed a positive role for intergovernmental competition in general and fiscal competition in particular can be found. There are two main ways. First, the role for intergovernmental competition can be compared to an auction mechanism to get resources allocated to their best possible uses. Another possibility is that there is an agency problem in government which tends to make the public sector inefficient and possibly too large. In this paper we shall concentrate on this agency problem to show that intergovernmental competition can be welfare enhancing. This is in stark contrast with EU stance on intergovernmental competition, which perceives it purely as messing up incentives with very damaging consequences for welfare. It should be stressed at the outset that the purpose is to present a “public choice” perspective on the topic of intergovernmental competition in a manner that is provocative to stimulate debate even if it is not found persuasive. The intention is to temper normative public economics analysis with some public choice perspectives. That does not mean that we claim the public choice approach to be the correct one. Normative

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